Singapore Banks - Maybank Kim Eng 2016-08-18: Pressure points

Singapore Banks - Pressure points

O&G exposure back to the fore

Although Swiber’s possible closure has been averted through negotiations with various stakeholders, this highlights the elevated risks to Singapore banks’ balance-sheet exposure to the beleaguered O&G support services sector. Post-2Q16 results, asset quality deteriorated with new NPAs mainly attributed to support services sector.

Although O&G is not the only sector to face further asset quality deterioration, in the face of a broader sluggish economic growth environment, it is arguably the biggest pressure point amongst the various sectors’ loan exposure at this moment. Here we examine scenarios to assess the impact from exposure on this front.

What if NPL ratio for support services hits 20-30%?

Singapore banks’ NPL ratio for O&G support services is ~3-15%, which we believe is low given where the credit cycle stands today. Hence we evaluate the impact for a couple of scenarios building in higher NPL ratio for support services of 20% and 30% respectively.

Banks do not disclose the provisions taken against the O&G support services NPLs. In our scenarios, we assume specific provisions are 30% of support services’ NPLs, which translates to ~40-50bps to group NPLs.

In both these scenarios, potential increase in specific provisions for DBS remains the largest amongst the three banks, at 216-374% vs UOB’s 43- 115% and OCBC’s 34-101%. If we were to assume banks stagger the increase in specific provisions equally for FY16 and FY17, net profits will decline the most for DBS at ~3-5%, and the least for UOB at ~1-2%.

However, our estimated book values will not be affected materially across the banks, at less than 0.5%. Our scenario analysis suggests UOB’s lower O&G exposure stands to benefit as compared to peers.

Maintain Negative; UOB has lowest O&G exposure

We remain Negative on the sector as we do not see any immediate rerating catalysts and believe bank balance sheets may face further downside risks from specific defaults or NPLs, albeit such risks are difficult to quantify.

We prefer UOB for its lower exposure to O&G and higher ability to raise credit spreads in a lacklustre lending environment.

1. O&G exposure back to fore

1.1 Bond yields spiked…

Swiber’s application for liquidation (which was later withdrawn) and subsequent application for judicial management bring back the banks’ O&G exposure to the fore again. Bond yields spiked for some of the smaller O&G players in Singapore and are now trading at 25-30% yields.

Some Singapore-listed O&G companies are overleveraged; close to half of the names have net debt/equity of above 100%.

1.2 Singapore banks’ O&G exposure

DBS has the largest exposure among Singapore banks at 7% of loans for the O&G sector. If we separate out the upstream and support services segment, which sees more risk than traders and downstream industries, DBS remains the most exposed at 5% of loans, i.e. SGD14b.

Based on our channel checks, we estimate UOB’s O&G NPL ratio is 5-6% and UOB’s support services NPL ratio is ~11-14%. The higher NPL ratio for OCBC explains the bank’s proactive efforts to place restructured loans as NPLs. 50% of OCBC’s O&G NPLs (~SGD470m) are still performing, i.e. paying interest.

2. Are provisions adequate?

The question is, are banks providing enough? Provision coverage for all banks declined since 3Q15. Credit costs are now near cyclical lows and will increase from here.

UOB has a bigger general provisions buffer at 1.5% vs 0.9-1.0% for peers. Its ratio has been raised pre-emptively in the past three years to counter potential slippages. UOB appears to be more conservative and best cushioned to absorb further losses from asset quality deterioration.

We think OCBC and DBS will be less prepared than UOB to handle asset quality deterioration given their lower buffer.

We currently assume credit costs of 32-44 bps for FY16-18E across the banks. We think this can be conservative if there are large corporate defaults or tail events that are unpredictable.

While the O&G sector is not the only area of concern facing further asset quality deterioration, the support services sector is facing stress and arguably the biggest pressure point at this moment. Given the relatively large exposure of Singapore banks to them, we want to assess the impact on specific provisions, net profits and book values if NPL ratio for support services sector hits 20% and 30% respectively, ceteris paribus.

If support services NPL ratio hits 20% and 30% in one fell swoop this year, banks’ FY16E Group NPL ratio will increase to 1.3-1.6% and 1.6-1.7% respectively, from our current estimate of 1.1-1.5%, ceteris paribus. It is difficult to estimate loan provisions with accuracy as these can be very dynamic and banks can have varying standards in their loan-loss methodologies. In addition, banks can always draw down on their general provisions to counter any shortfall.

In our scenario analysis, we assume support services’ NPLs require specific provisions of 30 cents per dollar of problem loans. This translates to ~40- 50bps of specific provisions to group NPLs. In Swiber’s case, DBS expects to recover ~50 cents for every dollar of Swiber’s exposure.

If support services NPL ratio hits 20% and 30%, we estimated the increase in specific provisions will be the largest for DBS, at 216-374%, followed by UOB at 43-115% and OCBC at 34-101%.

Banks are likely to stagger the increase in specific provisions instead of lumping it all in a year.

Assuming they stagger the increase in specific provisions equally over two years (FY16-17E), we estimate in both scenarios, DBS’s net profits for FY16-17E will decline the most from our current net profit estimates by ~3-5%, ceteris paribus. This is followed by OCBC at ~1-3% and UOB at ~1-2%. However, our estimated book values will not be affected materially across the banks, at less than 0.5%.

In conclusion, we think it is too early to jump back into the sector given lower profitability trends, asset-quality deterioration and rising capital constraints. We prefer UOB (HOLD, TP SGD18.34) for its lower exposure to O&G and higher ability to raise credit spreads in a lacklustre lending environment.

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